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Edited Transcript of SWP.TO earnings conference call or presentation 8-Aug-19 4:00pm GMT

Q2 2019 Swiss Water Decaffeinated Coffee Inc Earnings Call

Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Swiss Water Decaffeinated Coffee Inc earnings conference call or presentation Thursday, August 8, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Frank A. Dennis

Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director

* Iain Carswell

Swiss Water Decaffeinated Coffee Inc. - CFO

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Conference Call Participants

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* Robert Gibson

PI Financial Corp., Research Division - MD, Head of Research & Consumer Products Analyst

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Presentation

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Operator [1]

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Please stand by. Good day, ladies and gentlemen, and welcome to the Swiss Water Decaffeinated Coffee Second Quarter 2019 Earnings Call. (Operator Instructions) At this time, it's my pleasure to turn the floor over to Mr. Frank Dennis, CEO of Swiss Water Decaffeinated Coffee. Sir, the floor is yours.

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [2]

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Thank you, Tom. Good morning, everyone, and thank you for taking the time to join us today. And I'm Frank Dennis, President and CEO of Swiss Water Decaffeinated Coffee Company Inc. With me today is Iain Carswell, our CFO.

Iain and I are here to discuss Swiss Water's financial results for the 3 and 6 months ended June 30, 2019, which comprise the second quarter and first half of our current fiscal year. I'll begin today with a brief review of our results and some of the factors that are driving the steady growth of our volumes. Then, Iain will provide more detail about our financial performance before I return to talk about our outlook. After that, we'll be happy to take your questions.

Looking at our results. Since the beginning of the year, we've continued to win market share from our competitors and to increase sales to our existing customers. As a result, our total processing volumes were up by 18% in the second quarter and 21% for the first half.

This along with our ongoing efforts to reduce costs and enhance our production efficiency had a positive effect on our financial performance this year.

The volume increases came from across our total customer base and across all geographies. Looking at volumes by customer type. Shipments to roasters, those customers who roast and package coffee to sell to consumers in their own coffee shops or for home or office use, were up by 8% in the quarter and 21% for the first half.

The increase in business came from 2 effects. First, we sold more decaf coffee to existing roaster accounts as they grew their own businesses, either by adding new stores or distribution channels or expanding their offerings. We also gained new roaster customers, some of whom had previously sourced their decaffeinated coffees from one of the 2 legacy CO2 plants that shut down last year.

Shipments to importers, those customers who resell our coffees to roasters where and when they need it, were also up nicely growing 45% in the second quarter and 36% in the first half.

Slicing the roaster segment another way, specialty roaster account volumes grew by 21% in the quarter and 16% for the first half. And shipments to larger commercial roaster accounts were up 16% in the quarter and 24% year-to-date.

Our steady volume growth is also related to some significant trends affecting the markets that we serve. As I've outlined over the past few quarters, the overall market for decaffeinated coffee is expanding and continues to outpace the growth of the U.S. coffee market as a whole. Sales of specialty decaf coffee have been particularly strong, especially in out-of-home markets. Consumers simply want to drink better coffee and are prepared to pay for it.

An overall trend toward healthier eating and aversion to chemicals and additives are also helping drive up demand for our coffees. Affecting the coffee trade is the growing awareness and concern about the health and environmental hazards associated with methylene chloride, the main chemical used by our competitors to decaffeinate coffee.

Increasingly, roasters, importers and prospective customers and consumers are receptive to our proposition that the benefits of converting from coffees decaffeinated with chemicals to chemical-free processes like ours far outweigh the marginal incremental cost involved. To better position Swiss Water to benefit from these trends and leverage the strength of the Swiss Water brand, we are expanding our geographic reach, strengthening our sales teams and focusing our efforts on emerging opportunities. All of these initiatives are designed to enable us to continue growing our volumes and thus our profitability.

Before I talk about future plans and outlook, I'll turn the call over to Iain who will provide more details about our financial results. Iain?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [3]

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Thanks, Frank, and good morning. I'll begin with our revenues. Significant growth in our volumes that Frank outlined had a positive impact on our revenues, which are $24.2 million (sic) [$24.4 million] for the second quarter and $48.6 million for the first half, were up 8% and 11%, respectively, compared to last year.

The positive impact of the volume growth was partially offset by a lower coffee futures price or NY'C' this year.

During the second quarter, the NY'C' averaged $0.95 per pound compared to $1.17 per pound in Q2 2018. For the first half, the NY'C' averaged $0.97 per pound compared to $1.19 last year. A substantial proportion of our revenue comprises the amount we charge our customers for green coffee. And as we charge market rates for this coffee, our revenue falls when green coffee costs fall. Our revenues are also impacted by the U.S. to Canadian dollar exchange rate as the majority of our sales are billed in U.S. currency. This year, foreign exchange had a positive impact on revenues. In Q2, the U.S. dollar averaged CAD 134, and for the first half, it was CAD 133, an average of 4% in both periods compared to 2018 -- an increase of 4% in both periods compared to 2018.

Looking at the cost side, our second quarter cost of sales was $20.3 million, an increase of 8% over Q2 last year. For the year-to-date, cost of sales was $40.9 million, up 10% from the 2018 level. In both periods, the increase was consistent with the growth of our business. And impacting factors included higher variable production costs due to the significant increase in our processing volumes and annual labor cost increases due to inflation.

These are partially offset by the per pound decrease in green coffee cost due to the lower NY'C'.

Another factor that impacted the first half result was the significantly higher cost for natural gas in Q1 of this year. As I indicated on our last call, a pipeline explosion in Northern BC last October and an unusual polar vortex cold weather pattern in March of this year resulted in significant supply constraints and higher gas prices. These are onetime factors that have abated and are not expected to impact gas prices going forward.

Q2 gross profit was up 4% to $4.1 million as higher revenues more than offset the increase in our cost of sales. This resulted in a margin of 17%. For the first half, gross profit was up by 13% to $7.7 million, resulting in a margin improvement of 1% to a margin of 16% despite the higher national -- natural gas price.

Our improved gross profit and margin were primarily the result of our higher processing volumes. However, a sharp focus on managing the operating costs of the Swiss Water and Seaforth Supply Chain Solutions, our green coffee logistics business, also had a positive impact.

Operating expenses were $2.8 million in Q2 and $5.3 million for the first half, an increase of 13% in both periods compared to the 2018 level.

This year's higher expenses were the result of higher staffing and staff-related expenses as well as increased research and development activity during the second quarter.

Q2 operating income was $1.4 million, a decrease of $200,000 or 11% in the same period last year. However, 6-month operating income of $2.3 million was up by $0.2 million, a 12% improvement over the first half of 2018.

For the second quarter, Swiss Water reported net income of $1.4 million compared to net income of $1.3 million in Q2 2018. Year-to-date net income is $1.3 million compared to $1.8 million in the first half of last year.

This year's improved gross profit was offset by increases in both operating and nonoperating expenses, both of which impacted net income. The increase in nonoperating expenses was partially driven by the revaluation of an embedded derivative, higher finance expense in relation to interest on leases as a result of the adoption of IFRS 16 leases and interest on a construction loan also had a negative impact.

Earnings before interest, tax, depreciation and amortization or EBITDA for the second quarter was $3.1 million, up by $1.2 million or 66% over Q2 2018. First half EBITDA was $5.4 million, up $2.4 million or 82% over the same period last year.

In both periods, the significant increase in EBITDA was due in part to our adoption of the new accounting standards related to leases.

Operationally, EBITDA was enhanced by the strong growth in processing volumes, our ongoing efforts to enhance cost recovery and an increased financial contribution from our Seaforth subsidiary.

Going forward, Swiss Water plans to continue investing in a production infrastructure and human resources as we prepare for the significant growth in business we anticipate in the months and years to come.

Finally, turning to dividends. Subsequent to the end of the quarter, on July 15, we paid a quarterly cash dividend of $0.0625 per share to shareholders of record on June 28, 2019.

With that, I thank you for attending the call. I'll now hand back to Frank, who will tell you more about our expectations going forward. Frank?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [4]

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Thank you, Iain. Looking ahead to the balance of 2019. We expect to maintain our positive momentum and once again record strong growth in our annual volumes. We continue to see that a strong desire to drink excellent coffee throughout the day without worrying about caffeine consumption, coupled with a growing concern about methylene chloride, is helping us grow our business.

With demand growing and chemical-free decaffeination capacity constrained, we are well positioned to continue to grow. This is enabled by our new capacity coming on stream in the next 6 months and by having top-quality, premium decaffeinated green coffee. As always, our focus remains on growth in both immediate and long term.

Accordingly, we are investing in the resources we need to generate increased volumes as we respond to the heightened demand. Over the past several quarters, we have been expanding our sales efforts and strengthening our presence in Europe and other overseas markets, and this strategy is paying off nicely.

Since opening our new sales office in France in January, we've seen outstanding growth in sales to European customers, with volumes there up 125% in the second quarter and 83% year-to-date. As we continue to expand our business in Europe and elsewhere, overseas, we expect revenues from our international markets, which now comprise 57 different countries, will continue to grow in both dollar and percentage terms.

At the same time, we are expanding our ability to target-specific customer groups by selectively adding into our sales marketing team in the U.S., which are nearly 50% of sales and remains our largest single market by far. Again, these efforts are yielding results with sales in the U.S. up 9% in the second quarter and 12% year-to-date.

While these initiatives are increasing our expenses somewhat, they're beginning to generate the increased volumes we need to begin filling the capacity we have coming on stream later this year. And at the same time, we continue to look at every aspect of our operations with the goal to improve our efficiency, control our costs and enhance our margins without affecting product quality, which is paramount to everything we do.

Finally, construction of our new state-of-the-art decaffeination plant in Delta, BC is progressing on target toward commissioning as planned later this year.

In summary, our outlook for 2019 is very positive, with demand for specialty decaf coffees continuing to grow and Swiss Water having the best product, specialized knowledge and experience and the operational infrastructure to respond successfully.

So that wraps up our comments for today. And Iain and I would now be happy to answer any of your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Bob Gibson with PI Financial.

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Robert Gibson, PI Financial Corp., Research Division - MD, Head of Research & Consumer Products Analyst [2]

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You also got pretty decent sales growth out of Asia. Can we get a little color on what's going on there?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [3]

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We've had some really strong growth in Korea, which is a rapidly expanding market and a market that is picking up on the opportunities for the decaffeinated coffee excitement in South. They're actually figuring out how the product can be used. It's -- Korea is very late night market, which is interesting, which helps our category, so that's just been a focus area for us.

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Robert Gibson, PI Financial Corp., Research Division - MD, Head of Research & Consumer Products Analyst [4]

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Great. And on the sales force growth, is that complete? Like have you added all the bodies you want?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [5]

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Yes. Yes. We're where we're at. And we are essentially lapping full year figures right now.

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Robert Gibson, PI Financial Corp., Research Division - MD, Head of Research & Consumer Products Analyst [6]

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Okay, great. And it sounds like Delta is on track as far as the time line. And what about the cost?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [7]

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The cost remains on track, Bob. And we are -- we disclosed in the MD&A, there is -- we forecast in the region of $9.5 million cost to complete, which is not a material movement on where we were last time around. We're still on track. There's been no change in our budgeted cost.

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Robert Gibson, PI Financial Corp., Research Division - MD, Head of Research & Consumer Products Analyst [8]

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Perfect. And maybe any big sales wins that you could call out?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [9]

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Nothing by name, Bob. A lot of people on this call, so we tend not to kind of focus on names unless some of our customers kind of come along with us or give us approval. But with growth in virtually every geographic market, you can imagine that there are some pretty large names as well as a whole series of specialty higher-margin names as well.

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [10]

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What I would say or add to that, Bob, is that we're seeing a nice mix of growth coming from new customers and from our legacy underlying customer base, which is a nice balance, given the capacity improvement that we've got coming onstream.

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Operator [11]

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(Operator Instructions) We'll go next to [Michael Leo], private investor.

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Unidentified Participant, [12]

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So I had some questions about the new capacity expansion. So as you get closer to finishing this facility build out, what are your current thoughts on how long it will take to fill whatever capacity you would have before you need to spend a significant amount to grow that capacity again?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [13]

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It's a question that we receive a lot. What I would say is, if you extrapolate forward our current growth rate, you're probably looking at something in the region of 3 to 4 years to fill the plant. Obviously, we would target to try and accelerate our volume growth with the new capacity coming onstream. But I think as a fair estimate, extrapolating our current growth is the position that we are looking against at the moment or planning against.

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Unidentified Analyst, [14]

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Okay. Great. And how much of the facility would need to be utilized until you are operating it, say, at break-even? So how long would that sort of startup last phase go for?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [15]

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It's again -- it's an interesting question. We are actually looking at what's the right mix of production across our 3 production lines.

We would hope to have a new production line up and close to full capacity as quickly as possible, because we think there are some efficiencies in terms of production costs by running that line versus our oldest line that we have here. So that's the piece of work that we're still working through at the moment to understand what the right production mix is. And obviously we'll move down the line that generates the most efficiency for us as a business.

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Unidentified Participant, [16]

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Okay. Great. And then I also had a question. So what is your, I guess, general philosophy on paying your dividend, while you've been sort of ramping up that, and there seems to be -- you seem repositioned for increased growth going forward? Do you think it might be worthwhile to maybe take the dividend costs and reallocate those to, say, marketing or paying down debt?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [17]

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I think we've got a long history of paying a consistent dividend. I'd like to think that, that's the position that we will continue to align against.

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Operator [18]

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(Operator Instructions) We do have another question from [Randy Spivac] with -- he is a private investor.

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Unidentified Participant, [19]

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Just a quick question. Have you guys considered any kind of a U.S. listing in the future as well?

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Iain Carswell, Swiss Water Decaffeinated Coffee Inc. - CFO [20]

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I mean it's an interesting question again. I'd say at the moment, we've got a very big capital plan in terms of completing our capital -- our current project. I don't know, Frank, have you got anything to add on?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [21]

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Yes. I think that -- I think it's -- but periodically, we have evaluated the opportunity. Periodically, there's communication from outside organizations that would have us look at that. But in the very near future, I don't think that, that's on the table, but I wouldn't say no. I think that there are opportunities maybe for a broader base out there.

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Unidentified Participant, [22]

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Okay. Great. And then my last question is, are you seeing any changes in the competitive environment trying to produce decaffeinated coffee in such a manner as you folks? Or is it still pretty much as it has been?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [23]

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Yes. We -- there is -- basically one of the largest decaffeinators in the world based in Bremen is apparently, according to them, building a water decaffeination facility in Bremen, which is very interesting in that, that can bring additional capacity and will bring additional capacity on to the market, especially into Europe, which can essentially help the entire category, because the category is constricted right now. And certainly, larger organizations, I know, appreciate the ability to have more than one source of supply for supply consistency. So it's also interesting to ask that, that largest decaffeinator in the world has only done chemical decaffeination so far and the fact that they are adding water capacity, to us, is an indication that they believe that quite possibly, the future of decaffeination is not based with the paint-stripper methylene chloride.

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Unidentified Participant, [24]

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One other question I had. Do any of the major coffee retail chains, I guess, the household names, do any of them use -- still have products with this technology? Or is that an opportunity still?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [25]

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Are you based in Canada?

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Unidentified Participant, [26]

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I'm thinking about North America primarily, like the store names like Starbucks or Tim Hortons or someone like that?

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Frank A. Dennis, Swiss Water Decaffeinated Coffee Inc. - President, CEO & Director [27]

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Yes. That's kind of why I was asking. Well -- I mean Tim Hortons we've been doing business with for 17 or 18 years directly. And we constantly add new names to our business, and that would include larger names that you would know both in private-label grocery as well as specialty coffee shop names. In terms of the -- some of the biggest names with capacity constraints, I think that there is some limitation. However, we are constantly searching for additional volume. And you're seeing that in our results over the past 3 years.

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Operator [28]

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(Operator Instructions) There are no further question. Ladies and gentlemen, this does conclude today's teleconference. We appreciate your participation. You may disconnect at this time, and have a great day.